For good business leadership, big pay is not necessary

I always expect being CEO deserves to be paid more for the huge expectations he assumes in his role in a company. However, how much more is always the question. The common view is if its not enough the person will just walk away from the job. Now there is a view paying too much is not good for the company as well as for society in general. My view is too much money is not beneficial even for the recipient as any excess income  gets spent in most ways in a unproductive manner.

What Aviva didn’t know: Good CEOs don’t need millions

11 May 2012 Myriam Robin

In the United Kingdom, Aviva CEO Andrew Moss stepped down from his role on Wednesday after a shareholder revolt was triggered, in part, by the size of his executive pay packet – a whopping £960,000.

Over half (54%) of the insurer’s shareholders voted down the company’s compensation plan at the company’s annual general meeting last week, making Moss’ position untenable. He was Aviva’s CEO for five years, and presided over a 59% fall in the share price.

While no doubt concerning to business leaders, news like this must cheer consultant and adjunct professor at the UTS Centre for Capital Market Dysfunction, Jack Gray.

LeadingCompany spoke to Gray before Moss’ resignation, but it’s not presumptuous to guess he would welcome it: Gray argues the blowout in executive compensation seen in the past few decades isn’t good for companies, their shareholders, or more broadly, society.

“Studies show that when you have such massive CEO compensation, the average CEO at the bottom of the pack isn’t affected,” Gray says. “It’s way out of his or her reach anyway.”

“But who it does affect is middle-management in large firms – they become envious. And studies show productivity falls as a result of this.”

There are other good reasons not to pay big compensation packages:

  • Research has shown firms with effective governance tend not to pay high compensation to their leaders.
  • There’s no link between CEO pay and performance. In fact, evidence shows the opposite, Gray says. “The more you pay people, the more risks they take.”

Economic research has shown when workers in mechanical jobs, like factories, are given bonuses, they work harder. But that doesn’t bear out for executives doing knowledge work, Gray says, where high pay simply gives CEOs an incentive to “game” the system.

A classic example of this is executive options. They were introduced in the 1990s as a way to closely align the incentives of a firm’s management to those of its shareholders. And in theory, they should, if tied to a company’s long-term performance.

But the technical solution was gamed almost immediate, Gray says.

“When share prices went down boards just reset the strike price, or they set on a short-term basis of one year or three years. That gives management an incentive to act very short-term, and the value of these options increases with increasing volatility.”

Options are frequently tied to things outside the CEO’s control, which makes a mockery of their purpose. “I saw this at AMP when I was there… options there were set according to the sharemarket. So, if the Index went up you got paid more. Of course, that had nothing to do with us; it was luck! And suggestions to tie it to the share price of other financial services were dismissed.”

Gray acknowledges this is a global problem; one by no means tied to Australian companies, but in fact is far more entrenched in America.

But he argues it’s growing here as well, as Australia increasingly brings in CEOs from overseas.

“You pay caviar, you get greedy monkeys,” he says, turning the old maxim – pay peanuts, get monkeys – on its head. “That’s what infected us, we bring in CEOs from America, and they bring the greed with them.”

So what’s causing this, and how can it be fixed?

Gray says the answers aren’t clear because the incentives underlying modern listed companies are “broken”.

He argues there is no proper market for executive compensation. “No one is pushing the price down.”

Shareholders like those of Aviva are certainly not the norm; the number of remunerations packages voted down is in single digits. “Shareholders are too diverse to have real power,” he says. “Even collectively shareholders don’t have power. The real power lies with fund managers, and they’re part of the system.”

Fund managers – themselves executives – have a vested interest in maximising executive compensation, so the system is self-reinforcing, he explains, adding that executive remuneration consultants don’t help the problem either: they get paid a percentage of a CEO’s first-year salary.

Gray has written to billionaire investor Warren Buffet asking him to fund a prize to the economist who can come up with a solution to this predicament. He hasn’t heard back yet, but he’s got other benefactors in mind if Buffet doesn’t bite.

One solution is stronger independent boards. “But,” Gray says, “that’s too often not what boards are selected for.”

In Germany, they’ve solved the issue by having two boards: a normal one, and one comprised of employees, scientists and others relevant to the industry. Compensation goes through them, and this must play a role in CEO salaries in Germany being only 40 times those of the average worker (in America, they’re now 400 times those of the average worker).

Another, more controversial solution is simply to cap executive pay. “People call that a communist suggestion,” Gray says, “but most sporting teams have caps on salaries. There’s no reason why divisions of companies, or whole companies, can’t have some form of cap.”

High executive pay is also bad for society, Gray says.

He does not argue this from an equity point of view; he says it tilts money and talent away from industries in the long-term national interest, and into things like finance.

“Once you start paying people in certain industries and sectors enormous amounts of money, it attracts others,” he says. “People are being attracted to various sectors where they pay like that, and away from more productive areas. For example, in Australia engineers who are needed for mining are attracted to finance where they become financial engineers.”

People say executives need to be paid a lot because their skills are in such high demand, and worth a lot to the company. Gray doesn’t buy this.

“People say they’ll leave. If they’re doing it just for the money, they can’t be very good CEOs. Just call their bluff.”

“One of the things that keeps a perspective on it is that almost everyone in the world works without bonuses or massively high pay.”

“If I was hiring a manager… and I sensed they were only in it to make money, I’d walk away.”

“You don’t want someone where that’s their incentive.”

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